Clarium Capital bets on rates to rise more

Clarium Capital, the $2bn San Francisco hedge fund run by Peter Thiel, the Paypal co-founder, is betting that central banks will raise interest rates far more than most people expect after concluding that the global wave of liquidity is being generated by petrodollars.

Mr Thiel’s thesis is simple, if unconventional. Oil-rich Arab states and gas-rich Russia are earning $600bn a year, which they are investing back into geared financial assets such as structured products, hedge funds and property, supporting global asset prices. The resulting liquidity is helping the price of assets from London homes to equities to emerging market bonds bubble up.

Almost everybody agrees that there is a record amount of liquidity in the financial system, and that it is driving a boom in markets. What is not agreed is the source of the liquidity. And it matters, because it affects whether – and when – the liquidity could evaporate, something that would prompt markets to plummet.

If the source is China’s central bank building dollar investments to maintain the renminbi’s interest rate peg it would end only when the currency revalues.

If the source is low interest rates, then it will end as the current round of central bank tightening continues.

And if the source is financial innovation allowing better spreading of risk through products such as credit derivatives, we may have permanently raised the level of liquidity in the system.

Mr Thiel dismisses all these arguments, saying that while each has a part to play, none can properly explain the level of liquidity.

“It is basically being driven by recycled oil money,” he told the Financial Times.

“It is in effect a regressive trillion-dollar-a-year tax increase on middle-class consumers around the world. The money is sent back to Geneva or London, leveraged several times and invested in financial assets.”

This boom is unsustainable, because – unlike deflationary low-wage Chinese exports – the petrodollar profits come from a shortage of oil, or as Mr Thiel says, it is a “super-inflationary story”.

“There is far more inflation than people realise but the standard inflation measures are not adequately measuring it because it is showing up only in asset prices so far,” he says.

Mr Thiel is only one hedge fund manager out of several thousand. But he is noteworthy, and not just because he managed to ride out the dotcom boom and sell Paypal for $1.5bn, securing himself a small fortune in the process. Clarium returned an annualised 33.1 per cent from its start in October 2002 to the end of April this year. The fund had its first bad year in 2006, losing 7.8 per cent, according to an investor, after taking too bearish an approach.

Clarium is now looking for low-risk ways to profit from the petrodollar analysis. One is simply to avoid what Mr Thiel considers the most inflated assets: London property, Chinese stocks, art.

Another is to look for areas where the petrodollar money is not going to – ironically including the oil companies avoided by Gulf and Russian investors, who want to diversify away from the industry.

A riskier play is interest rate futures. If Mr Thiel is right, short-term rates will have to rise sharply to stop asset inflation feeding through to consumer prices – making the yield curve even more inverted than at present.

Monetarism has gone out of fashion among economists, but Mr Thiel points to similarities between now and early 1979, with the yield curve starting the year inverted and credit spreads tight – a combination that has been sustained only once since then, during the dotcom bubble.

In 1979, petrodollar-driven inflation ended with sharp rate rises imposed by monetarists at central banks. Mr Thiel, an avid chess player, thinks history could repeat itself – although he warns it may take a while to reach the “endgame”.